CFIN
5th Edition
ISBN: 9781305661639
Author: Scott Besley, Eugene Brigham
Publisher: Cengage Learning
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Chapter 5, Problem 17PROB
Summary Introduction
Maturity risk premium:
Premium required for accepting the risk on the specific security.
Calculate the maturity risk premium as follows:
Given nine months Treasury bill yield is 2.3%. Yield on three years bond is 2.9% and yield on years bonds yield is 4.3%. Bonds does not have liquidity premium.
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The Wall Street Journal reports that the current rate on 8-year Treasury bonds is 5.85 percent, the rate on a 15-year Treasury bond is 6.25 percent, and the rate on a 15-year corporate bond issued by MHM Corp. is 7.35 percent. Assume that the maturity risk premium is zero. If the default risk premium and the liquidity risk premium on the 8-year corporate bond issued by MHM Corp. are the same as those on the 15-year corporate bond, calculate the current rate on MHM Corp.'s 8-year corporate bond.
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- Currently, a one-year Treasury bill is yielding 2.7 percent. Company F's three-year bond has a yield equal to 5.3 percent, and its seven-year bond has a yield equal to 6.9 percent. Although none of the bonds has a liquidity premium, any bond with a maturity equal to one year or longer has a maturity risk premium (MRP). Except for their terms to maturity, the characteristics of the bonds are the same. Compute the annual MRP associated with the bonds. Round your answer to one decimal place. _____ % Compute the default risk premium (DRP) associated with the bonds. Round your answer to one decimal place. _____ %arrow_forwardAssume that the real, risk-free rate of interest is expected to be constant over time at 3 percent, and that the annual yield on a 6-year corporate bond is 8.00 percent, while the annual yield on a 10-year corporate bond is 7.75 percent: you may assume that the default risk and liquidity premium are the same for both bonds. Also assume that the maturity risk premium for all securities can be estimated as MRP, (0.1%) *(t-1), where t is the number of periods until maturity. Finally assume that inflation is expected to be constant at 3 percent for Years 1-6, and then constant at some rate for Years 7-10 (4 years). Given this information, determine what the market must anticipate the average annual rate of inflation will be for Years 7-10. 2.583% O 1979% 2.281% 1.375 % O 1.677 % 4arrow_forwardSuppose that the current one-year rate (one-year spot rate) and expected one-year government bonds over years 2, 3 and 4 are as follows: 1R₁ = 4.80%, E(2r₁) = 5.45%, E(3r₁) = 5.95%, E(41) = 6.10% Assume that there are no liquidity premiums. To the nearest basis point, what is the current rate for the four-year-maturity government bond? A. 5.57% B. 5.62% C. 5.83% D. 6.10%arrow_forward
- What is the default risk premium on Aaa corporate bond, if the interest rate on that bond is 3.25 percent and the interest rate on a Treasury security is 1.16 percent?arrow_forwardPlease see attached. Definitions: Yield to maturity (YTM) is the return the bond holder receives on the bond if held to maturity. Treasury note is a U.S. government bond with a maturity of between two and ten years. Current yield is the annual bond coupon payment divided by the current price.arrow_forwardA particular security’s equilibrium rate of return is 8 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 3.5 percent. The security’s liquidity risk premium is .25 percent and maturity risk premium is .85 percent. The security has no special covenants. Calculate the security’s default risk premium. You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants.The Wall Street Journal reports that one-year T-bills are currently earning 3.25 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real interest rate " 2.25% Default risk premium " 1.15% Liquidity risk premium " 0.50% Maturity risk premium " 1.75% What is the inflation premium? What is the fair interest rate on Moore Corporation 30-year bonds?arrow_forward
- A Treasury bond due in one year has a yield of 5.7%; a Treasury bond due in 5 years has a yield of 6.2%. A bond issued by Ford due in 5 years has a yield of 7.5%; a bond issued by Shell Oil due in one year has a yield of 6.5%. The default risk premiums on the bonds issued by Shell and Ford, respectively, are: a. 0.8% and 1.3%. b. None of the options are correct. c. 0.7% and 1.5%. d. 1.2% and 1.0%. e. 1.0% and 1.2%.arrow_forwardWhich of the following statements is CORRECT? O The yield on á 5-year Treasury bond cannot exceed the yield on a 20-year Treasury bond. O The following represents a "possibly reasonable" formula for the maturity risk premium on bonds: MRP = -0.1% (t), where t is the years to maturity. O The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5- year AAA-rated corporate bond. O The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. O The yield on a 10-year corporate bond should always exceed the yield on a 10-year Treasury bond.arrow_forwardThe Wall Street Journal reports that the current rate on 6-year Treasury bonds is 6.70 percent, the rate on 13-year Treasury bonds is 7.10 percent, and the rate on a 13-year corporate bond issued by MHM Corp. Is 9.05 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on an 6-year corporate bond issued by MHM Corp. are the same as those on the 13-year corporate bond, calculate the current rate on MHM Corp's 6-year corporate bond. (Round your answer to 2 decimal places.) Current rate 1%arrow_forward
- The real risk-free rate is 3 percent. Inflation is expected to average 2 percent a year for the next 3 years, after which the inflation is expected to average 3.5 percent a year. Assume that there is no maturity risk premium. A 7-year corporate bond has a yield of 7.6 percent. Assume that the liquidity premium on the corporate bond is 0.4 percent. What is the default risk premium on the corporate bond?arrow_forwardA BBB-rated corporate bond has a yield to maturity of 13.6%. A U.S. Treasury security has a yield to maturity of 11.8%. These yields are quoted as APRS with semiannual compounding. Both bonds pay semiannual coupons at an annual rate of 12.4% and have five years to maturity. a. What is the price (expressed as a percentage of the face value) of the Treasury bond? b. What is the price (expressed as a percentage of the face value) of the BBB-rated corporate bond? c. What is the credit spread on the BBB bonds?arrow_forwardAnswer number 1 and 2: 1.) Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 2.15%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. 2.) Koy Corporation's 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) × 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy's bonds?arrow_forward
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